Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley Chapter 6 HUMAN CAPITAL

Human capital So far, “labor” is the OTHER factor of production (other than K) Yet not all workers are of equal “quality” Healthy and unhealthy Educated and not educated The human input to production may be seen as a type of capital (HUMAN CAPITAL) “Human capital” – HK – comes in two main types: health and education 3-2

Human capital is “capital” HK shares many features of physical capital Human capital may be productive Human capital is itself produced through the process of education and training –Not a natural resource Human capital earns a rate of return, which motivates its production –Educated or healthier worker earns higher wage –Good-looking workers earn 12% higher wage than less good- looking workers Human capital also wears out 3-3

6-4 Human capital is positively correlated with Gdp per capita 1. Nutrition versus GDP per Capita

6-5 Human capital is positively correlated with Gdp per capita 2. Life Expectancy Versus GDP per Capita

6-6 Human capital is positively correlated with Gdp per capita 3. Average Years of Schooling Versus GDP per Capita

HK and per-capita Gdp: what is causing what? Is economic development (that is: higher per-capita Gdp) that feeds into higher health and education Or rather are well-fed and well-educated workers to be more productive and raise per-capita Gdp? Who knows? Problem solved with statistical methods 3-7 Human capital Per-capita Gdp

The rate of return to education Problem in computing economic return to education: HK is “embodied” in each person Idea Educated people typically earn a higher market wage compared to people with no education Premium varies with amount and quality of education Take total number of schooling years as a proxy –Doesn’t account for different quality of schooling 3-8

These are average values for rich and poor countries 6-9 Returns to schooling are diminishing % on primary education – 10.1% on low secondary – 6.8% for higher secondary and tertiary

How to compute the rate of return (r.o.r) to education What is the r.o.r. to the first year of schooling? 13.4%, that is a person who has gone to school for one year will earn times the salary of a person with no schooling How about two years of schooling (with respect to no- schooling)? W 2 = W 0 = 1.29 W 0 How about five years of schooling (wrt no-schooling)? W 5 = ( x 1.101) W 0 = 1.82 W 0 The educational premium to 5 years of schooling is 82% 3-10

In the U.S. the educational premium has gone up a lot over time. This is true for the rest of the world as well 6-11 Ratio of Tertiary Wages to High- School Wages

How much of the cross-country income gaps is explained by education? We have pinpointed big differences in countries’ levels of HK Now want to understand the extent to which such differences translate into differences in income per capita across countries We just focus on schooling (and not on training or other informal ways of accumulating HK) 3-12

6-13 Quantitative implications of Y = Ak α (hL) 1-α = (h 1-α A) K α L 1-α Formula (6.1) answers the question: What would it be the income gap between country “i” and “j” when the two countries exhibit identical A, n and δ?

Example Problem: In country j number of years of schooling is two; in country i it is 12. Compute the income gap in the steady state h j = x h 0 = 1.29 x h 0 h i = x x x h 0 = 3.16 x h 0 Hence: y i ss /y j ss = h i /h j = 3.16 / 1.29 =

Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley 6-15 More systematically: predicted versus Actual GDP per Worker using schooling years

What is left out of our model Quality of schooling Externalities 3-16